If you’ve never heard of DRIPs you shouldn’t feel bad. After all, it’s an unusual stockbroker who will recommend a stock program when no brokerage commissions are involved. DRIPs are direct investment plans, also known as dividend reinvestment plans, offered by companies that enable shareholders to build investment portfolios by reinvesting dividends into more shares.
DRIPs are a great way to begin investing with a small amount of money because they carry no brokerage commissions and no transactions fees. The absence of fees allows you to invest small amounts and accumulate shares slowly over a period of time instead of making lump-sum investments. What’s more, corporations love them because they’ve proven themselves to be a good way of raising capital.
DRIPs have always been popular with do-it-yourself investors, in particular parents who use them to buy stocks for their children. Unfortunately dividends have shrunk in recent years and have made it harder to build a large portfolio based on reinvested dividends. Despite recent improvements, over the past couple years they have yielded less than 2 percent, while over that same time dividends were taxed at the investors’ ordinary income rate, up to nearly 40 percent for wealthy investors. Even middle-income investors, who are much more likely to own DRIPs, paid nearly 30 percent of their dividends over to the government.
There are different types of DRIPs. A company-run DRIP allows investors to buy directly through it without first owning a single share (although this is not always the case). Company-run DRIPs are normally administered from corporate headquarters as part of the overall shareholder relations effort. Some companies may even offer individual retirement accounts along with the DRIP. A transfer agent–run DRIP is run by a third party because managing a DRIP often entails extensive man hours. Because they can use the same resources for a number of customers, transfer agents can often provide DRIP management services at a lower cost than the company could achieve by itself. And with a a brokerage-run DRIP, shareholders can reinvest dividends at no cost, even if the company in question doesn’t have a formal DRIP. These brokerage-run simulated plans apply to dividends only and don’t permit optional cash purchases, which are a large part of what makes DRIP plans so attractive.
One of the reasons DRIPs are so popular is because they benefit both the investors and the corporations. An investor will usually save brokerage fees or will be offered other discounts that a corporation will provide in order to keep the investor. Some investors may also enjoy the benefits of the option to purchase more shares in a company they already know and trust rather than searching through the thousands of options available to them in the free market.
DRIPs allow corporations to raise capital inexpensively and can also help provide stability for a company’s stock price by offering perpetual demand for the company’s shares as new dividends are declared. Furthermore, the corporation may decrease or increase the availability and benefits of its DRIPs based on how much capital it needs to raise.